MF0011 Slides Unit 01

MF 0011Mergers & Acquisitions
Unit 1-Introduction to Mergers and Acquisitions

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Program : MBA
Semester : III
Subject Code : MF 0011
Subject Name : Mergers & Acquisitions
Unit number : 1
Unit Title : Introduction to Mergers and Acquisitions
Lecture Number :
Lecture Title : Introduction to Mergers and Acquisitions

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Introduction to Mergers and Acquisitions
Objectives:

After studying this unit, you should be able to:
Define the meaning of Mergers and Acquisitions (M & A)
Describe the motives behind the M & A
State the advantages and disadvantages of M & A
Classify the types of mergers
Explain the steps to be taken for a successful merger

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Lecture Outline
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Introduction
Meaning: Mergers & Acquisitions
Types of Mergers
Motives Behind Mergers
Mergers & Acquisitions: Advantages
Mergers & Acquisitions: Disadvantages
Mergers & Acquisitions: Types
Mergers & Acquisitions: Examples
Steps to a Successful Merger
Mergers & Acquisitions: Historical Overview
Summary
Glossary
Check Your Learning
Answers
Case Study
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Introduction: Mergers and Acquisitions
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The hallmark of any successful business is profitable growth.
Making profits and increase in volumes year on year is necessary for growth to
be profitable.
Profitable Growth
Organic Growth
Inorganic Growth
Increase in volumes by the business on its
own, acquiring fresh customers, making
and selling new products and entering new
markets with its products.
When businesses realise their growth is
steady, not spectacular, some businesses
take the leap for inorganic growth or
growth by acquiring businesses. That is,
mergers and acquisitions.
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Meaning: Merger & Acquisitions
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Merger is defined as a combination where two or more than two
companies combine into one company. In this process one company
survives and others lose their corporate existence. The survivor acquires
assets as well as liabilities of the merged company or companies.
Amalgamation is the merger of one or more companies (amalgamating
company/ companies) with another company (amalgamated company) or
the merger of two or more companies to form a new company in such
away that all assets and liabilities of the amalgamating company or
companies become assets and liabilities of the amalgamated
company.
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Meaning: Merger & Acquisitions (Cont.)
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Acquisition refers to the procurement of assets by one company from
another company.
Takeover: In an acquisition, both companies may continue to exist. It is also
known as a 'takeover'. It is buying of one company by another. Acquisition
usually refers to a purchase of a smaller firm by a larger one.
Reverse Takeover: Sometimes, a smaller firm will acquire management
control of a larger or longer established company and keep its name for
the combined entity. This is known as a reverse takeover.
The terms demerger, spin-off and spin-out are used to indicate a situation
where one company splits into two, generating a second company.
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Types of Mergers
Mergers
Absorption: Grouping two or more companies
into an existing company. All companies except
one lose their identity in a merger through
absorption.
Consolidation: Known as the fusion of two or
more than two companies into a new company
in which all the existing companies are legally
dissolved and a new company is created.
Examples of Mergers/ Acquisitions:
Aditya Birla group, owned HINDALCO acquired NOVELLIS for US$6 billion.
TATA MOTORS acquired LANDROVER for $2.3 billion.
Takeover of European Steel major CORUS for $12.2 Billion by TATA STEEL, the biggest
ever acquisition by an lndian company.
Example: Merger of Tata
Chemical Ltd (buyer) and
Tata Fertilisers Ltd (seller),
to form Tata Chemical Ltd.
Example: Hindustan
Computers Ltd, Hindustan
instruments Ltd, Indian
Software Ltd and Indian Repro
graphics Ltd was merged to
form HCL, a new company.
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Motives Behind Mergers
Sensible Reasons
Strategic Reasons
Economies of Scale
Economies of Vertical Integration
Complementary Resources
Tax Shield
Utilization of Surplus Funds
Managerial Effectiveness
Dubious Reasons
Diversification
Lower Financing Costs
Earnings Growth
A merger can be rated as sensible when it adds value, i.e., it creates additional
benefit to the parties involved.
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Motives Behind Merger: Sensible
Reasons (Cont.)
Strategic benefits:
If a firm has decided to enter or expand in a particular industry, acquisition of a
firm engaged in that industry, rather than dependence on internal expansion,
may offer several strategic advantages.
Prevention of a competitor from establishing a similar position in the
industry.
Offers a 'timing' advantage since a merger can bypass several stages in the
expansion process
May entail less risk and even less cost

Economies of Scale:
Helps in Efficient and proper usage of distribution networks,
Improved production capacities,
Economies in research and development facilities, engineering services, data
processing systems etc.
In case of horizontal mergers scope for utilizing resources is greater hence
more prominent economies of scale
In case of vertical mergers, benefits include better coordination of activities,
higher market power and lower inventory levels.
In conglomerate mergers, there is a possibility of cutting down on overhead
expenses
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Economies of Vertical Integration
Achieved when more firms, which are at different levels of production, get
merged. For Example: A oil production company merging with a company
refining oil and marketing: This will improve the control and co-ordination
In case of companies producing units in-house, vertical merger is not a good
idea. Here, outsourcing with better performing suppliers in the respective
segments may not be useful.

Complementary resources
Sensible to merge companies with complementary resources
For Example: A company bringing in a new product will need the help of a
company with good engineering capabilities and better marketing network:
Easier for manufacturing and marketing the new product. The complementary
resources will improve the new worth more than they are separately.

Tax Shield:
When a company with unabsorbed depreciation and/or accumulated losses
merges with a better performing company, tax shields can be utilized.
In case of its merger with a profit-making company, its accumulated losses
and/or absorbed depreciation can be set off against the profits of the profit-
making firm and tax benefits can be realised faster.
Reasons (Cont.)
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Utilization of surplus funds
A merger through cash compensation with other companies is helpful in
situations where a company is generating good revenue but has no investing
opportunities. In such situations, the firms need to distribute higher dividends
and even has to buy back it shares. Managements however prefer further
investments, thought they may or may not be profitable, hence effectively
utilizing the surplus funds.

Managerial Effectiveness
Increases managerial efficiency when a poor-performing team is replaced
with a better-performing one
Greater similarity between shareholders and managers, leading to creation
of a disciplined and better work environment
In cases where managers feel that poor performance of their firm may lead
to a merger, they would work for better performance
Firm plagued with managerial inadequacies can gain immensely from the
superior management that is likely to merge as a consequence of merger
Reasons (Cont.)
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Diversification:
Risk reduction by diversification: The degree of risk will depend on the
correlation of earnings of both the entities.
This value is questionable, because any investor who wants to reduce risk
can create a portfolio by diversifying two companies. The merger is not
necessary for the investor to get benefitted by positives of diversification.
The company's home-made diversifications offers better flexibility

Lower Financing Costs
Many believe that the consequence of larger size and greater earnings
stability is to reduce the cost of borrowing for the merged firm: Creditors
of the merged firm enjoy better protection than independent firms

Example: If two firms A and B merge, the creditors of the merged firm are
protected by equities of both A and B. This reduces the cost of debt, and it
imposes an extra burden on the shareholders since shareholders of firm A
must support the debt to firm B and vice versa.
In an efficient market, the benefit to the shareholders from lower cost of
debt would be set off by the additional risk borne by them, and there would
be no net gain.

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Motives Behind Merger: Dubious
Reasons
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Earnings Growth
A merger may create appearance of growth in earnings stimulating a price
increase if the investors are fooled.
Example: Company A acquired Company B. The pre-merger financial position
shows that A has superior growth prospects and commands a price earnings
(P/E) multiple of 20, while B has an inferior growth prospects and has price
earnings of 10. The merger is not expected to create any additional value. The
exchange ratio is fixed at 1:2 that is 1 share of A is given in exchange for two
shares of B.

Situation l - The market is 'smart': The financial position of A after the merger
is better and the earnings per share rises, but the market recognises that the
growth prospect of the combined firm will not be as bright as that of A alone. So
the market price per share remains unchanged and the P/E ratio falls. Here the
market value of the combined company is simply the sum of the market values
of the merging companies.
Situation 2 - The market is 'foolish': It may regard the increase in earnings per
share of A as reflection of true growth and so the market price of A will rise and
the P/E ratio will stay the same.
Motives Behind Merger: Dubious
Reasons (Cont.)
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Mergers & Acquisitions: Advantages
Economies of scale helps in lowering the costs
To Shareholders
Promoters get the advantage of restructuring the
company
To Promoters
Managers often look forward to mergers as an opportunity
to enhance their status financially and otherwise.
To Managers
The benefits of mergers get passed to the consumers in
the form of better products and services.
To Consumers
For detailed explanation on the
advantages of mergers and
acquisitions to various sections
of the society, Click here
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Mergers & Acquisitions: Disadvantages
Merger must be approved by the stock holders of the firm. Typically,
two-thirds (or even more) of the votes are required for approval.
Obtaining the necessary votes can be time-consuming and difficult.
The cooperation of the management of the target firm is a necessity.
There can also be diseconomies of scale if the business becomes too
large.
Clashes of culture between different types of businesses could happen
and reduce the effectiveness of the integration.
Merger may create a conflict of objectives between the different
businesses.
In view of sharing of services, staff positions may come down and this
will result in employee dissatisfaction.
A merger can be extremely beneficial to all stakeholders of a business
but if handled wrongly it can cause serious disruption all round
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Mergers & Acquisitions : Types
Types of M & A
Horizontal
Concentric
Vertical
Circular Combination
Conglomerate
For detailed explanation
on the types of mergers
and acquisitions,
please click here.
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Mergers & Acquisitions : Examples
Merger of Phoenix Electric (India) and Phoenix Lamps (India) (Concentric
Combination)
Merger of Videocon Narmada Electronics and Videocon International Ltd
(Concentric Combination)
Merger of bank of Madura and ICICI (Concentric Combination)
Acquisition of Blue Dart to DHL Worldwide (Concentric Combination)
Acquisition of Thomson SA of France by Videocon India in a deal worth$290
million (Concentric Combination)
Indian Airlines and Air India (Concentric Combination)
Standard Equity Fund and Dr. Reddys Laboratories (Circular Combination)
Karnataka Scooters and Brooke Bond (India) Ltd (Circular Combination)
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Steps to Successful Merger
Mergers need careful planning to achieve financial goals, reduce problems
and for profit-making. For employees, possibility of changes and uncertainty
at work place can create stress. This affects judgments, perceptions, and
interpersonal relationships.
Often reduced communication and increased centralisation as part of re-
structuring in companies creates space for rumours and insecurity in
employees.
Circulate a consistent
message in the
combining entities
from top down.
Maintain consistent
accountability and
compensation
throughout the
company for similar
positions.
Find out new ways of
structuring the
company to bridge
corporate culture
differences.
Establish gaugeable
objectives, especially
in areas, which will
be working together
for a common goal.
Revamp the
compensation plan to
recognise the
additional work
required by
transition.
Plan different ways
for people to get to
know each other.
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Stats:
The United States Federal Trade Commission reports that the number of filings
in 1999 was almost three times the number received in 1993. This same trend
is being experienced worldwide. Web property deals tripled from 140 in 1998 to
450 in 1999 with an incredible increase of 700% in dollar spending from 1998
to 1999.
Facts and Figures:
Acquisition of Time Warner by America Online was the highest acquisition in
terms of amount spent. This being more than three times the total spent in
1998/1999.
Mergers are not just between the internet-related businesses, but across
industries.
Late 1990s to 2000 Mergers and Acquisitions were at an all-time high
Till 2005 M & A slowed down due to economic slowdown.
companies did not have the cash to buy other companies.
2004-05 Economy revived, businesses had cash. The end of 2004
saw many deals:
Sprint combining with Nextel
K-Mart Holding Corp buying Sears
Mergers & Acquisitions: Historical
Overview
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A merger or amalgamation should be considered only after careful
examination of the merits and demerits, and ensuring overall positive
value addition.
Merger is defined as a combination where two or more than two
companies combine into one company.
Mergers may happen for various reasons - Sensible Reasons like:
Economies of Scale, Economies of Vertical Integration, Complementary
Resources, Tax Shield, Utilization of Surplus Funds or Managerial
Effectiveness, and dubious Reasons like: Diversification, Lower Financing
Costs, Earnings Growth.
M & A offers a bunch of advantages to its shareholders, promoters,
managers and consumers in different ways.
There are 5 types of mergers: Horizontal, Concentric, Vertical, circular
Combination and Conglomerate mergers.

Summary

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Merger: Merger is a grouping of two or more companies into one company.
Acquisition: The term acquisition refers to the acquisition of assets by one
company from another company.
Spin-off: An independent company carved out of another company (of which
it was a part) through a sale.
Conglomerate: Combination of companies engaged in unrelated businesses
Glossary

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Check Your Learning
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1. Growth achieved internally is termed as organic growth. (True/False)
2. Amalgamation is a synonym of merger. (True/False)
3. Consolidation is known as the fusion of two or more companies into a new
company. (True/False)
4. Growth achieved by M & A is termed as organic growth. (True/False)
5. Acquisitions mean acquiring all the assets and liabilities of another company.
(True/False)
6. Deal between Tata Motors and Land Rover was a kind of merger. (True/False)
7. An acquisition may be friendly or hostile. (True/False)
8. Economies of scale are most prominent in the case of ___________.
9. Most common reason behind mergers is to achieve _________ through
diversification.
10.One of the many potential benefits of merger is an increase in
_________________.
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Check Your Learning
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11.A company may use a specific _______________ or assets to widen the
scope of its activities.
12.Acquisitions and mergers are strategic decisions. (True/False)
13.The decision of M & A requires approval by one-third of shareholders voting.
(True/False)
14.Under _____________ the acquiring firm belongs to the industry of the
target company.
15.Conglomerate merger is the combination of companies engaged in
_________________.
16.Combination of two or more companies involved in different stages of
activities is called _____________.
17.Vertical combination is of two types _________________ and backward
integration.
18.Combinations of companies engaged in the production of different products
are called ______________.
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Check Your Learning
19.Web property deals increased three-fold from 140 in 1998 to 450 in 1999
with an incredible increase of 700%. (True/False)
20.America Online's acquisition of Time Warner was valued at more than three
times the total 1998/1999 M & A spending. (True/False)
21.For the success of a merger ______________ among the merging
businesses is very important.
22.Productivity drops by as much as _________________ have been reported.
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Answers
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1. True.
2. True.
3. True.
4. False.
5. True.
6. False.
7. True.
8. Horizontal mergers.
9. Risk reduction.
10. Managerial effectiveness.
11. Set of skills.
12. True.
13. False.
14. Horizontal merger.
15. Unrelated businesses.
16. Vertical merger.
17. Forward integration.
18. Circular combination.
19. True.
20. True.
21. Cultural integration.
22. 50%.
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Case Study
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Click on the icon besides, to
analyze the case on Corporate
Restructuring
Answer the following questions, based on the
given case:

Question
Discuss the case given above.
Hint answer:
The deal will bring a lot of opportunities for the
company and strengthen Subexs position in the
revenue maximisation space of telecom sector.

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Unit 1-Introduction to Mergers and Acquisitions

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